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Section 1: 10-Q (10-Q)


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2018

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

Commission file number: 000-25927

MACATAWA BANK CORPORATION
(Exact name of registrant as specified in its charter)

Michigan
 
38-3391345
(State or other jurisdiction of  incorporation or organization)
 
(I.R.S. Employer Identification No.)

10753 Macatawa Drive, Holland, Michigan 49424
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (616) 820-1444
 


Indicate by checkmark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ☐
Accelerated filer ☒
Non-accelerated filer ☐
Smaller reporting company ☐
Emerging Growth Company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

The number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 34,017,525 shares of the Company's Common Stock (no par value) were outstanding as of April 26, 2018.
 


Forward-Looking Statements

This report contains forward-looking statements that are based on management's beliefs, assumptions, current expectations, estimates and projections about the financial services industry, the economy, and Macatawa Bank Corporation. Forward-looking statements are identifiable by words or phrases such as “outlook”, “plan” or “strategy”; that an event or trend “could”, “may”, “should”, “will”, “is likely”, or is “possible” or “probable” to occur or “continue”, has “begun” or “is scheduled” or “on track” or that the Company or its management “anticipates”, “believes”, “estimates”, “plans”, “forecasts”, “intends”, “predicts”, “projects”, or “expects” a particular result, or is “committed”, “confident”, “optimistic” or has an “opinion” that an event will occur, or other words or phrases such as “ongoing”, “future”, “signs”, “efforts”, “tend”, “exploring”, “appearing”, “until”, “near term”, “concern”, “going forward”, “focus”, “starting”, “initiative,” “trend” and variations of such words and similar expressions. Such statements are based upon current beliefs and expectations and involve substantial risks and uncertainties which could cause actual results to differ materially from those expressed or implied by such forward-looking statements. These statements include, among others, those related to future levels of earning assets, future composition of our loan portfolio, future impact of tax reform on our earnings, trends in credit quality metrics, future capital levels and capital needs, including the impact of Basel III, real estate valuation, future levels of repossessed and foreclosed properties and nonperforming assets, future levels of losses and costs associated with the administration and disposition of repossessed and foreclosed properties and nonperforming assets, future levels of loan charge-offs, future levels of other real estate owned, future levels of provisions for loan losses and reserve recoveries, the rate of asset dispositions, future dividends, future growth and funding sources, future cost of funds, future liquidity levels, future profitability levels, future interest rate levels, future net interest margin levels, the effects on earnings of changes in interest rates, future economic conditions, future effects of new or changed accounting standards, future loss recoveries, loan demand and loan growth and the future level of other revenue sources. Management's determination of the provision and allowance for loan losses, the appropriate carrying value of intangible assets (including deferred tax assets) and other real estate owned, and the fair value of investment securities (including whether any impairment on any investment security is temporary or other-than-temporary and the amount of any impairment) involves judgments that are inherently forward-looking. All statements with references to future time periods are forward-looking. All of the information concerning interest rate sensitivity is forward-looking. Our ability to sell other real estate owned at its carrying value or at all, successfully implement new programs and initiatives, increase efficiencies, maintain our current levels of deposits and other sources of funding, maintain liquidity, respond to declines in collateral values and credit quality, increase loan volume, originate high quality loans, maintain or improve mortgage banking income, realize the benefit of our deferred tax assets, continue payment of dividends and improve profitability is not entirely within our control and is not assured. The future effect of changes in the real estate, financial and credit markets and the national and regional economy on the banking industry, generally, and Macatawa Bank Corporation, specifically, are also inherently uncertain. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions (“risk factors”) that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may materially differ from what may be expressed or forecasted in such forward-looking statements. Macatawa Bank Corporation does not undertake to update forward-looking statements to reflect the impact of circumstances or events that may arise after the date of the forward-looking statements.

Risk factors include, but are not limited to, the risk factors described in "Item 1A - Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2017. These and other factors are representative of the risk factors that may emerge and could cause a difference between an ultimate actual outcome and a preceding forward-looking statement.
 

INDEX

   
Page
Number
     
Part I.
Financial Information:
 
     
 
Item 1.
 
 
Consolidated Financial Statements
4
     
 
Notes to Consolidated Financial Statements
10
     
 
Item 2.
 
 
Management's Discussion and Analysis of Financial Condition and Results of Operations
39
     
 
Item 3.
 
 
Quantitative and Qualitative Disclosures About Market Risk
52
     
 
Item 4.
 
 
Controls and Procedures
54
     
Part II.
Other Information:
 
     
 
Item 2.
 
 
Unregistered Sales of Equity Securities and Use of Proceeds
55
     
 
Item 6.
 
 
Exhibits
55
     
Signatures
  56
 

Index
Part I Financial Information
Item 1.
MACATAWA BANK CORPORATION
CONSOLIDATED BALANCE SHEETS
As of March 31, 2018 (unaudited) and December 31, 2017
(Dollars in thousands, except per share data)

 
     
March 31,
2018
     
December 31,
2017
  
ASSETS
           
Cash and due from banks
 
$
26,954
   
$
34,945
 
Federal funds sold and other short-term investments
   
103,898
     
126,522
 
Cash and cash equivalents
   
130,852
     
161,467
 
Debt securities available for sale, at fair value
   
214,269
     
220,720
 
Debt securities held to maturity (fair value 2018 - $90,536 and 2017 - $86,452)
   
90,513
     
85,827
 
Federal Home Loan Bank (FHLB) stock
   
11,558
     
11,558
 
Loans held for sale, at fair value
   
---
     
1,208
 
Total loans
   
1,325,545
     
1,320,309
 
Allowance for loan losses
   
(16,675
)
   
(16,600
)
Net loans
   
1,308,870
     
1,303,709
 
Premises and equipment – net
   
46,110
     
46,629
 
Accrued interest receivable
   
5,200
     
4,680
 
Bank-owned life insurance
   
40,494
     
40,243
 
Other real estate owned - net
   
5,223
     
5,767
 
Net deferred tax asset
   
3,982
     
3,785
 
Other assets
   
6,709
     
4,639
 
Total assets
 
$
1,863,780
   
$
1,890,232
 
                 
LIABILITIES AND SHAREHOLDERS' EQUITY
               
Deposits
               
Noninterest-bearing
 
$
453,993
   
$
490,583
 
Interest-bearing
   
1,106,879
     
1,088,427
 
Total deposits
   
1,560,872
     
1,579,010
 
Other borrowed funds
   
80,667
     
92,118
 
Long-term debt
   
41,238
     
41,238
 
Accrued expenses and other liabilities
   
5,627
     
4,880
 
Total liabilities
   
1,688,404
     
1,717,246
 
                 
Commitments and contingent liabilities
   
---
     
---
 
                 
Shareholders' equity
               
Common stock, no par value, 200,000,000 shares authorized;  34,017,525 and 33,972,977 shares issued and outstanding at March 31, 2018 and December 31, 2017
   
217,573
     
217,081
 
Retained deficit
   
(38,836
)
   
(42,526
)
Accumulated other comprehensive income (loss)
   
(3,361
)
   
(1,569
)
Total shareholders' equity
   
175,376
     
172,986
 
Total liabilities and shareholders' equity
 
$
1,863,780
   
$
1,890,232
 
 
See accompanying notes to consolidated financial statements.
 
- 4 -

Index
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
Three month periods ended March 31, 2018 and 2017
(unaudited)
(Dollars in thousands, except per share data)

 
 
Three Months
Ended
March 31,
2018
   
Three Months
Ended
March 31,
2017
 
Interest income
           
Loans, including fees
 
$
13,710
   
$
12,455
 
Securities
               
Taxable
   
868
     
639
 
Tax-exempt
   
876
     
538
 
FHLB Stock
   
197
     
124
 
Federal funds sold and other short-term investments
   
368
     
92
 
Total interest income
   
16,019
     
13,848
 
Interest expense
               
Deposits
   
994
     
481
 
Other borrowings
   
369
     
382
 
Long-term debt
   
474
     
402
 
Total interest expense
   
1,837
     
1,265
 
Net interest income
   
14,182
     
12,583
 
Provision for loan losses
   
(100
)
   
(500
)
Net interest income after provision for loan losses
   
14,282
     
13,083
 
Noninterest income
               
Service charges and fees
   
1,049
     
1,060
 
Net gains on mortgage loans
   
141
     
428
 
Trust fees
   
925
     
778
 
ATM and debit card fees
   
1,278
     
1,201
 
Gain on sales of securities
   
---
     
3
 
Bank owned life insurance ("BOLI") income
   
238
     
238
 
Other
   
501
     
523
 
Total noninterest income
   
4,132
     
4,231
 
Noninterest expense
               
Salaries and benefits
   
6,194
     
5,999
 
Occupancy of premises
   
1,072
     
1,026
 
Furniture and equipment
   
805
     
732
 
Legal and professional
   
202
     
225
 
Marketing and promotion
   
229
     
227
 
Data processing
   
695
     
682
 
FDIC assessment
   
132
     
136
 
Interchange and other card expense
   
332
     
313
 
Bond and D&O Insurance
   
110
     
117
 
Net (gains) losses on repossessed and foreclosed properties
   
406
     
(85
)
Administration and disposition of problem assets
   
55
     
180
 
Other
   
1,202
     
1,336
 
Total noninterest expenses
   
11,434
     
10,888
 
Income before income tax
   
6,980
     
6,426
 
Income tax expense
   
1,225
     
1,966
 
Net income
 
$
5,755
   
$
4,460
 
Basic earnings per common share
 
$
0.17
   
$
0.13
 
Diluted earnings per common share
 
$
0.17
   
$
0.13
 
Cash dividends per common share
 
$
0.06
   
$
0.04
 
 
See accompanying notes to consolidated financial statements.
 
- 5 -

Index
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Three month periods ended March 31, 2018 and 2017
(unaudited)
(Dollars in thousands)

 
   
Three Months
Ended
March 31,
2018
   
Three Months
Ended
March 31,
2017
 
             
Net income
 
$
5,755
   
$
4,460
 
                 
Other comprehensive income:
               
                 
Unrealized gains (losses):
               
Net change in unrealized gains (losses) on debt securities available for sale
   
(2,299
)
   
1,063
 
Tax effect
   
483
     
(372
)
Net change in unrealized gains (losses) on debt securities available for sale, net of tax
   
(1,816
)
   
691
 
                 
Less: reclassification adjustments:
               
Reclassification for gains included in net income
   
---
     
3
 
Tax effect
   
---
     
(1
)
Reclassification for gains included in net income, net of tax
   
---
     
2
 
                 
Other comprehensive income (loss), net of tax
   
(1,816
)
   
689
 
Comprehensive income
 
$
3,939
   
$
5,149
 
 
See accompanying notes to consolidated financial statements.
 
- 6 -

Index
MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Three month periods ended March 31, 2018 and 2017
(unaudited)
(Dollars in thousands, except per share data)

 
   
Common
Stock
   
Retained
Deficit
   
Accumulated
Other
Comprehensive
Income (Loss)
   
Total
Shareholders'
Equity
 
Balance, January 1, 2017
 
$
216,731
   
$
(53,008
)
 
$
(1,484
)
 
$
162,239
 
Net income for the three months ended March 31, 2017
   
---
     
4,460
     
---
     
4,460
 
Cash dividends at $.04 per share
   
---
     
(1,357
)
   
---
     
(1,357
)
Net change in unrealized loss on securities available for sale, net of tax
   
---
     
---
     
689
     
689
 
Stock compensation expense
   
114
     
---
     
---
     
114
 
Balance, March 31, 2017
 
$
216,845
   
$
(49,905
)
 
$
(795
)
 
$
166,145
 
                                 
Balance, January 1, 2018, as reported
 
$
217,081
   
$
(42,804
)
 
$
(1,291
)
 
$
172,986
 
Cumulative effect adjustment upon adoption of ASU 2018-02
   
---
     
278
     
(278
)
   
---
 
Balance, January 1, 2018, adjusted
 
$
217,081
   
$
(42,526
)
 
$
(1,569
)
 
$
172,986
 
Reclassification for equity securities upon adoption of ASU 2016-01
   
---
     
(24
)
   
24
     
---
 
Net income for the three months ended March 31, 2018
   
---
     
5,755
     
---
     
5,755
 
Cash dividends at $.06 per share
   
---
     
(2,041
)
   
---
     
(2,041
)
Repurchase of 452 shares for taxes withheld on vested restricted stock
   
(5
)
   
---
     
---
     
(5
)
Issuance of 45,000 shares for stock option exercise
   
386
     
---
     
---
     
386
 
Net change in unrealized loss on debt securities available for sale, net of tax
   
---
     
---
     
(1,816
)
   
(1,816
)
Stock compensation expense
   
111
     
---
     
---
     
111
 
Balance, March 31, 2018
 
$
217,573
   
$
(38,836
)
 
$
(3,361
)
 
$
175,376
 

See accompanying notes to consolidated financial statements.
 
- 7 -

MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three month periods ended March 31, 2018 and 2017
(unaudited)
(Dollars in thousands)

 
   
Three Months
Ended
March 31,
2018
   
Three Months
Ended
March 31,
2017
 
Cash flows from operating activities
           
Net income
 
$
5,755
   
$
4,460
 
Adjustments to reconcile net income to net cash from operating activities:
               
Depreciation and amortization
   
534
     
537
 
Stock compensation expense
   
111
     
114
 
Provision for loan losses
   
(100
)
   
(500
)
Origination of loans for sale
   
(5,140
)
   
(16,960
)
Proceeds from sales of loans originated for sale
   
6,489
     
16,802
 
Net gains on mortgage loans
   
(141
)
   
(428
)
Gain on sales of securities
   
---
     
(3
)
Write-down of other real estate
   
280
     
64
 
Net gain (loss) on sales of other real estate
   
126
     
(149
)
Deferred income tax expense
   
285
     
162
 
Change in accrued interest receivable and other assets
   
(1,120
)
   
869
 
Earnings in bank-owned life insurance
   
(238
)
   
(238
)
Change in accrued expenses and other liabilities
   
747
     
664
 
Net cash from operating activities
   
7,588
     
5,394
 
                 
Cash flows from investing activities
               
Loan originations and payments, net
   
(5,354
)
   
14,862
 
Purchases of securities available for sale
   
(8,502
)
   
(8,867
)
Purchases of securities held to maturity
   
(5,305
)
   
---
 
Proceeds from:
               
Maturities and calls of securities
   
10,158
     
6,457
 
Sales of securities available for sale
   
---
     
3,440
 
Principal paydowns on securities
   
1,760
     
1,109
 
Sales of other real estate
   
431
     
320
 
Additions to premises and equipment
   
(142
)
   
(462
)
Net cash from investing activities
   
(6,954
)
   
16,859
 
                 
Cash flows from financing activities
               
Change in deposits
   
(18,138
)
   
(15,578
)
Repayments and maturities of other borrowed funds
   
(11,451
)
   
(1,388
)
Proceeds from other borrowed funds
   
---
     
20,000
 
Proceeds from exercise of stock options
   
386
     
---
 
Repurchase of shares for taxes withheld on vested restricted stock
   
(5
)
   
---
 
Cash dividends paid
   
(2,041
)
   
(1,357
)
Net cash from financing activities
   
(31,249
)
   
1,677
 
Net change in cash and cash equivalents
   
(30,615
)
   
23,930
 
Cash and cash equivalents at beginning of period
   
161,467
     
89,819
 
Cash and cash equivalents at end of period
 
$
130,852
   
$
113,749
 
 
See accompanying notes to consolidated financial statements.
 
- 8 -

MACATAWA BANK CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Three month periods ended March 31, 2018 and 2017
(unaudited)
(Dollars in thousands)

 
 
 
Three Months
Ended
March 31,
2018
 
 
Three Months
Ended
March 31,
2017
 
Supplemental cash flow information
           
Interest paid
 
$
1,828
   
$
1,272
 
Income taxes paid
   
---
     
---
 
Supplemental noncash disclosures:
               
Transfers from loans to other real estate
   
293
     
56
 
Security settlement
   
---
     
236
 

See accompanying notes to consolidated financial statements.
 
- 9 -

MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation: The accompanying consolidated financial statements include the accounts of Macatawa Bank Corporation ("the Company", "our", "we") and its wholly-owned subsidiary, Macatawa Bank ("the Bank"). All significant intercompany accounts and transactions have been eliminated in consolidation.

Macatawa Bank is a Michigan chartered bank with depository accounts insured by the Federal Deposit Insurance Corporation. The Bank operates 26 full service branch offices providing a full range of commercial and consumer banking and trust services in Kent County, Ottawa County, and northern Allegan County, Michigan.

The Company owns all of the common stock of Macatawa Statutory Trust I and Macatawa Statutory Trust II. These are grantor trusts that issued trust preferred securities and are not consolidated with the Company under accounting principles generally accepted in the United States of America.

Basis of Presentation: The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) believed necessary for a fair presentation have been included.

Operating results for the three month period ended March 31, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018. For further information, refer to the consolidated financial statements and related notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2017.

Use of Estimates:  To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information.  These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ.  The allowance for loan losses, valuation of deferred tax assets, loss contingencies, fair value of other real estate owned and fair values of financial instruments are particularly subject to change.

Allowance for Loan Losses: The allowance for loan losses (allowance) is a valuation allowance for probable incurred credit losses inherent in our loan portfolio, increased by the provision for loan losses and recoveries, and decreased by charge-offs of loans. Management believes the allowance for loan losses balance to be adequate based on known and inherent risks in the portfolio, past loan loss experience, information about specific borrower situations and estimated collateral values, economic conditions and other relevant factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Management continues its collection efforts on previously charged-off balances and applies recoveries as additions to the allowance for loan losses.

The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component covers non-classified loans and is based on historical loss experience adjusted for current qualitative factors. The Company maintains a loss migration analysis that tracks loan losses and recoveries based on loan class and the loan risk grade assignment for commercial loans. At March 31, 2018, an 18 month annualized historical loss experience was used for commercial loans and a 12 month historical loss experience period was applied to residential mortgage loans and consumer loans. These historical loss percentages are adjusted (both upwards and downwards) for certain qualitative factors, including economic trends, credit quality trends, valuation trends, concentration risk, quality of loan review, changes in personnel, external factors and other considerations.

A loan is impaired when, based on current information and events, it is believed to be probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified and a concession has been made, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.
 
- 10 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Commercial and commercial real estate loans with relationship balances exceeding $500,000 and an internal risk grading of 6 or worse are evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated and the loan is reported at the present value of estimated future cash flows using the loan’s existing interest rate or at the fair value of collateral, less estimated costs to sell, if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment and they are not separately identified for impairment disclosures.

Troubled debt restructurings are also considered impaired with impairment generally measured at the present value of estimated future cash flows using the loan’s effective rate at inception or using the fair value of collateral, less estimated costs to sell, if repayment is expected solely from the collateral.

Foreclosed Assets: Assets acquired through or instead of loan foreclosure, primarily other real estate owned, are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed unless they add value to the property.

Income Taxes: Income tax expense is the sum of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax consequences of temporary differences between the carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

The Company recognizes a tax position as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the "more likely than not" test, no tax benefit is recorded. The Company recognizes interest and penalties related to income tax matters in income tax expense.

During the first quarter of 2018, the Company adopted ASU 2018-02, allowing for the reclassification of the income tax effects of the revaluation the deferred tax impact on accumulated other comprehensive income due to the enactment of tax reform at the end of 2017.  The Company’s only component of accumulated other comprehensive income is the fair value adjustment for securities available for sale.  Upon adoption of this ASU, a transfer was made from AOCI to retained earnings in the amount of  $278,000.

Revenue Recognition:  The Company recognizes revenues as they are earned based on contractual terms, as transactions occur, or as services are provided and collectability is reasonably assured.  The Company’s primary source of revenue is interest income from the Bank’s loans and investment securities.  The Company also earns noninterest revenue from various banking services offered by the Bank.

Interest Income: The Company’s largest source of revenue is interest income which is primarily recognized on an accrual basis based on contractual terms written into loans and investment contracts.

Noninterest Revenue:  The Company derives the majority of its noninterest revenue from: (1) service charges for deposit related services, (2) gains related to mortgage loan sales, (3) trust fees and (4) debit and credit card interchange income.  Most of these services are transaction based and revenue is recognized as the related service is provided.

Derivatives:  Certain of the Bank’s commercial loan customers have entered into interest rate swap agreements directly with the Bank.  At the same time the Bank enters into a swap agreement with its customer, the Bank enters into a corresponding interest rate swap agreement with a correspondent bank at terms mirroring the Bank’s interest rate swap with its commercial loan customer.   This is known as a back-to-back swap agreement.  Under this arrangement the Bank has five freestanding interest rate swaps, each of which are carried at fair value.  As the terms mirror each other, there is no income statement impact to the Bank.  At March 31, 2018 and December 31, 2017, the total notional amount of such agreements was $53.9 million and $42.3 million and resulted in a derivative asset with a fair value of $60,000 and $197,000, respectively, which were included in other assets and a derivative liability of $60,000 and $197,000, respectively, which were included in other liabilities.

Reclassifications: Some items in the prior period financial statements were reclassified to conform to the current presentation.
 

- 11 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Adoption of New Accounting Standards:  FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.  The new standard requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income.  The ASU also requires public business entities to use exit price notation when measuring the fair value of financial instruments for disclosure purposes and requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset.   The new standard was effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The impact of adoption of this ASU by the Company was not material, but did result in a reclassification of an equity investment from securities available for sale to other assets with its related market value changes reflected in earnings for the three months ended March 31, 2018.  In addition, the fair value disclosures for financial instruments in Note 5 are computed using an exit price notion as required by the ASU.

FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606).  The amendments in this Update create a new topic in the Codification, Topic 606. In addition to superseding and replacing nearly all existing U.S. GAAP revenue recognition guidance, including industry-specific guidance, ASC 606 establishes a new control-based revenue recognition model, changes the basis for deciding when revenue is recognized over time or at a point in time, provides new and more detailed guidance on specific topics and expands and improves disclosures about revenue.  In addition, ASU 2014-09 adds a new Subtopic to the Codification, ASC 340-40, Other Assets and Deferred Costs: Contracts with Customers, to provide guidance on costs related to obtaining a contract with a customer and costs incurred in fulfilling a contract with a customer that are not in the scope of another ASC Topic.   The new guidance does not apply to certain contracts within the scope of other ASC Topics, such as lease contracts, insurance contracts, financing arrangements, financial instruments, guarantees other than product or service warranties, and nonmonetary exchanges between entities in the same line of business to facilitate sales to customers. The amendments are effective for annual periods and interim periods within those annual periods beginning after December 15, 2017.  Adoption of this ASU effective January 1, 2018 did not materially affect the financial results of the Company.  Additional disclosure has been added to Note 1 disclosing the composition of the Company’s noninterest revenue.

FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments (a consensus of the FASB Emerging Issues Task Force).  This ASU addresses concerns regarding diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows.  In particular, this ASU addresses eight specific cash flow issues in an effort to reduce this diversity in practice: (1) debt prepayment or debt extinguishment costs; (2) settlement of zero-coupon bonds; (3) contingent consideration payments made after a business combination; (4) proceeds from the settlement of insurance claims; (5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; (6) distributions received from equity method investees; (7) beneficial interests in securitization transactions; and (8) separately identifiable cash flows and application of the predominance principle.  The amendments are effective for annual periods beginning after December 15, 2017, and for interim periods within those annual periods.  The impact of adoption of this ASU by the Company on January 1, 2018 was not material.

FASB issued ASU No. 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.  This ASU allows a company to make a one-time reclassification from accumulated other comprehensive income to retained earnings for the stranded tax effects resulting from the Tax Cuts and Jobs Act, which was enacted at the end of 2017.  ASU 2018-02 is effective for all entities with periods beginning after December 15, 2018, and interim periods within those fiscal years.  Early adoption is permitted, including adoption in any interim period for which financial statements have not yet been issued.  The amendments in ASU 2018-02 are to be applied either in the period of adoption, or retrospectively to each period in which the effect of the change in the US federal corporate income tax rate is recognized.  The ASU requires a disclosure of the accounting policy for releasing income tax effects from accumulated other comprehensive income.  The Company early adopted this ASU in the first quarter of 2018 and has recorded a reclassification adjustment of $278,000 decreasing accumulated other comprehensive income and increasing retained earnings, effective December 31, 2017, and has included discussion as part of the Income Taxes accounting policy disclosure.
 
- 12 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Newly Issued Not Yet Effective Standards:  FASB issued ASU 2016-02, Leases. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement.  The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.  As the Company owns most of its branch locations, this ASU will apply primarily to operating leases and the impact of adoption of this ASU by the Company is not expected to be material.

FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.  This ASU provides financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date by replacing the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates.  The new guidance eliminates the probable initial recognition threshold and, instead, reflects an entity’s current estimate of all expected credit losses. The new guidance broadens the information that an entity must consider in developing its expected credit loss estimate for assets measured either collectively or individually to include forecasted information, as well as past events and current conditions. There is no specified method for measuring expected credit losses, and an entity is allowed to apply methods that reasonably reflect its expectations of the credit loss estimate. Although an entity may still use its current systems and methods for recording the allowance for credit losses, under the new rules, the inputs used to record the allowance for credit losses generally will need to change to appropriately reflect an estimate of all expected credit losses and the use of reasonable and supportable forecasts. Additionally, credit losses on available-for-sale debt securities will now have to be presented as an allowance rather than as a write-down. This ASU is effective for fiscal years beginning after December 15, 2019, and for interim periods within those years.  The Company has selected a software vendor for applying this new ASU and has scheduled implementation of the software to begin in the second quarter of 2018 and is currently evaluating the impact of this new ASU on its consolidated financial statements.

FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities.  This ASU simplifies and expands the eligible hedging strategies for financial and nonfinancial risks by more closely aligning hedge accounting with a company’s risk management activities, and also simplifies the application of Topic 815, Derivatives and Hedging, through targeted improvements in key practice areas.  This includes expanding the list of items eligible to be hedged and amending the methods used to measure the effectiveness of hedging relationships.  In addition, the ASU prescribes how hedging results should be presented and requires incremental disclosures.  These changes are intended to allow preparers more flexibility and to enhance the transparency of how hedging results are presented and disclosed.  Further, the ASU provides partial relief on the timing of certain aspects of hedge documentation and eliminates the requirement to recognize hedge ineffectiveness separately in earnings in the current period.  The ASU is effective for years beginning after December 15, 2018, and interim periods within those years.  The Company does not expect the impact of adoption of this ASU to be material.
 
- 13 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 2 – SECURITIES

The amortized cost and fair value of securities at period-end were as follows (dollars in thousands):
 
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
March 31, 2018
                       
Available for Sale:
                       
U.S. Treasury and federal agency securities
 
$
96,250
   
$
3
   
$
(2,224
)
 
$
94,029
 
U.S. Agency MBS and CMOs
   
26,282
     
12
     
(692
)
   
25,602
 
Tax-exempt state and municipal bonds
   
43,375
     
215
     
(551
)
   
43,039
 
Taxable state and municipal bonds
   
44,481
     
2
     
(936
)
   
43,547
 
Corporate bonds and other debt securities
   
8,135
     
---
     
(83
)
   
8,052
 
   
$
218,523
   
$
232
   
$
(4,486
)
 
$
214,269
 
Held to Maturity
                               
Tax-exempt state and municipal bonds
 
$
90,513
   
$
399
   
$
(376
)
 
$
90,536
 
 
   
Amortized
Cost
   
Gross
Unrealized
Gains
   
Gross
Unrealized
Losses
   
Fair
Value
 
December 31, 2017
                       
Available for Sale:
                       
U.S. Treasury and federal agency securities
 
$
103,309
   
$
---
   
$
(1,345
)
 
$
101,964
 
U.S. Agency MBS and CMOs
   
23,797
     
7
     
(419
)
   
23,385
 
Tax-exempt state and municipal bonds
   
41,684
     
519
     
(146
)
   
42,057
 
Taxable state and municipal bonds
   
44,267
     
10
     
(542
)
   
43,735
 
Corporate bonds and other debt securities
   
8,149
     
1
     
(41
)
   
8,109
 
Other equity securities
   
1,500
     
---
     
(30
)
   
1,470
 
   
$
222,706
   
$
537
   
$
(2,523
)
 
$
220,720
 
Held to Maturity
                               
Tax-exempt state and municipal bonds
 
$
85,827
   
$
806
   
$
(181
)
 
$
86,452
 
 
There were no sales of securities in the three month period ended March 31, 2018.  Proceeds from the sale of securities available for sale were $3.4 million in the three month period ended March 31, 2017 resulting in net gains on sale of $3,000 as reported in the Consolidated Statements of Income.  This resulted in reclassifications of $3,000 ($2,000 net of tax) from accumulated other comprehensive income to gain on sale of securities in the Consolidated Statements of Income in the three month period ended March 31, 2017.
 
- 14 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 2 – SECURITIES (Continued)

Contractual maturities of debt securities at March 31, 2018 were as follows (dollars in thousands):
 
   
Held–to-Maturity Securities
   
Available-for-Sale Securities
 
   
Amortized
Cost
   
Fair
Value
   
Amortized
Cost
   
Fair
Value
 
Due in one year or less
 
$
12,922
   
$
12,922
   
$
14,010
   
$
13,968
 
Due from one to five years
   
28,927
     
29,083
     
120,593
     
118,125
 
Due from five to ten years
   
16,342
     
16,415
     
57,498
     
56,433
 
Due after ten years
   
32,322
     
32,116
     
26,422
     
25,743
 
   
$
90,513
   
$
90,536
   
$
218,523
   
$
214,269
 
 
Securities with unrealized losses at March 31, 2018 and December 31, 2017, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows (dollars in thousands):
 
   
Less than 12 Months
   
12 Months or More
   
Total
 
 
March 31, 2018
 
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
U.S. Treasury and federal agency securities
 
$
48,139
   
$
(899
)
 
$
40,364
   
$
(1,261
)
 
$
88,503
   
$
(2,160
)
U.S. Agency MBS and CMOs
   
17,523
     
(468
)
   
5,843
     
(224
)
   
23,366
     
(692
)
Tax-exempt state and municipal bonds
   
36,847
     
(739
)
   
4,092
     
(188
)
   
40,939
     
(927
)
Taxable state and municipal bonds
   
32,174
     
(565
)
   
10,172
     
(371
)
   
42,346
     
(936
)
Corporate bonds and other debt securities
   
9,345
     
(106
)
   
2,233
     
(41
)
   
11,578
     
(147
)
Total temporarily impaired
 
$
144,028
   
$
(2,777
)
 
$
62,704
   
$
(2,085
)
 
$
206,732
   
$
(4,862
)
 
   
Less than 12 Months
   
12 Months or More
   
Total
 
 
December 31, 2017
 
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
   
Fair
Value
   
Unrealized
Loss
 
U.S. Treasury and federal agency securities
 
$
50,614
   
$
(439
)
 
$
43,787
   
$
(876
)
 
$
94,401
   
$
(1,315
)
U.S. Agency MBS and CMOs
   
16,719
     
(249
)
   
6,228
     
(170
)
   
22,947
     
(419
)
Tax-exempt state and municipal bonds
   
20,124
     
(243
)
   
4,208
     
(82
)
   
24,332
     
(325
)
Taxable state and municipal bonds
   
30,331
     
(279
)
   
9,781
     
(265
)
   
40,112
     
(544
)
Corporate bonds and other debt securities
   
8,021
     
(42
)
   
2,250
     
(29
)
   
10,271
     
(71
)
Other equity securities
   
---
     
---
     
1,470
     
(30
)
   
1,470
     
(30
)
Total temporarily impaired
 
$
125,809
   
$
(1,252
)
 
$
67,724
   
$
(1,452
)
 
$
193,533
   
$
(2,704
)
 
- 15 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 2 – SECURITIES (Continued)

Other-Than-Temporary-Impairment

Management evaluates securities for other-than-temporary impairment ("OTTI") at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. Management determined that the unrealized losses for each period were attributable to changes in interest rates and not due to credit quality.  As such, no OTTI charges were necessary during the three month periods ended March 31, 2018 and 2017.

Securities with a carrying value of approximately $2.0 million were pledged as security for public deposits, letters of credit and for other purposes required or permitted by law at March 31, 2018 and December 31, 2017.
 
NOTE 3 – LOANS

Portfolio loans were as follows (dollars in thousands):
 
   
March 31,
2018
   
December 31,
2017
 
Commercial and industrial
 
$
477,088
   
$
465,208
 
                 
Commercial real estate:
               
Residential developed
   
11,528
     
11,888
 
Unsecured to residential developers
   
2,392
     
2,332
 
Vacant and unimproved
   
41,786
     
39,752
 
Commercial development
   
1,153
     
1,103
 
Residential improved
   
79,533
     
90,467
 
Commercial improved
   
294,866
     
298,714
 
Manufacturing and industrial
   
98,612
     
97,679
 
Total commercial real estate
   
529,870
     
541,935
 
                 
Consumer
               
Residential mortgage
   
234,443
     
224,452
 
Unsecured
   
197
     
226
 
Home equity
   
77,666
     
82,234
 
Other secured
   
6,281
     
6,254
 
Total consumer
   
318,587
     
313,166
 
                 
Total loans
   
1,325,545
     
1,320,309
 
Allowance for loan losses
   
(16,675
)
   
(16,600
)
   
$
1,308,870
   
$
1,303,709
 
 
- 16 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 – LOANS (Continued)

Activity in the allowance for loan losses by portfolio segment was as follows (dollars in thousands):


Three months ended March 31, 2018
 
Commercial
and
Industrial
   
Commercial
Real Estate
   
Consumer
   
Unallocated
   
Total
 
Beginning balance
 
$
6,478
   
$
6,590
   
$
3,494
   
$
38
   
$
16,600
 
Charge-offs
   
(66
)
   
---
     
(31
)
   
---
     
(97
)
Recoveries
   
34
     
203
     
35
     
---
     
272
 
Provision for loan losses
   
60
     
(261
)
   
105
     
(4
)
   
(100
)
Ending Balance
 
$
6,506
   
$
6,532
   
$
3,603
   
$
34
   
$
16,675
 
 
Three months ended March 31, 2017
 
Commercial
and
Industrial
   
Commercial
Real Estate
   
Consumer
   
Unallocated
   
Total
 
Beginning balance
 
$
6,345
   
$
6,703
   
$
3,871
   
$
43
   
$
16,962
 
Charge-offs
   
---
     
---
     
(26
)
   
---
     
(26
)
Recoveries
   
23
     
162
     
75
     
---
     
260
 
Provision for loan losses
   
101
     
(267
)
   
(329
)
   
(5
)
   
(500
)
Ending Balance
 
$
6,469
   
$
6,598
   
$
3,591
   
$
38
   
$
16,696
 
 
- 17 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method (dollars in thousands):
 
 
March 31, 2018
 
Commercial
and
Industrial
   
Commercial
Real Estate
   
Consumer
   
Unallocated
   
Total
 
Allowance for loan losses:
                             
Ending allowance attributable to loans:
                             
Individually reviewed for impairment
 
$
448
   
$
346
   
$
586
   
$
---
   
$
1,380
 
Collectively evaluated for impairment
   
6,058
     
6,186
     
3,017
     
34
     
15,295
 
Total ending allowance balance
 
$
6,506
   
$
6,532
   
$
3,603
   
$
34
   
$
16,675
 
                                         
Loans:
                                       
Individually reviewed for impairment
 
$
6,768
   
$
5,629
   
$
7,871
   
$
---
   
$
20,268
 
Collectively evaluated for impairment
   
470,320
     
524,241
     
310,716
     
---
     
1,305,277
 
Total ending loans balance
 
$
477,088
   
$
529,870
   
$
318,587
   
$
---
   
$
1,325,545
 
 
 
December 31, 2017
 
Commercial
and
Industrial
   
Commercial
Real Estate
   
Consumer
   
Unallocated
   
Total
 
Allowance for loan losses:
                             
Ending allowance attributable to loans:
                             
Individually reviewed for impairment
 
$
497
   
$
197
   
$
514
   
$
---
   
$
1,208
 
Collectively evaluated for impairment
   
5,981
     
6,393
     
2,980
     
38
     
15,392
 
Total ending allowance balance
 
$
6,478
   
$
6,590
   
$
3,494
   
$
38
   
$
16,600
 
                                         
Loans:
                                       
Individually reviewed for impairment
 
$
6,402
   
$
7,332
   
$
8,345
   
$
---
   
$
22,079
 
Collectively evaluated for impairment
   
458,806
     
534,603
     
304,821
     
---
     
1,298,230
 
Total ending loans balance
 
$
465,208
   
$
541,935
   
$
313,166
   
$
---
   
$
1,320,309
 
 
- 18 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents loans individually evaluated for impairment by class of loans as of March 31, 2018 (dollars in thousands):
 
 
March 31, 2018
 
Unpaid
Principal
Balance
   
Recorded
Investment
   
Allowance
Allocated
 
With no related allowance recorded:
                 
Commercial and industrial
 
$
981
   
$
981
   
$
---
 
                         
Commercial real estate:
                       
Residential developed
   
---
     
---
     
---
 
Unsecured to residential developers
   
---
     
---
     
---
 
Vacant and unimproved
   
---
     
---
     
---
 
Commercial development
   
---
     
---
     
---
 
Residential improved
   
1,078
     
1,078
     
---
 
Commercial improved
   
1,896
     
1,896
     
---
 
Manufacturing and industrial
   
---
     
---
     
---
 
     
2,974
     
2,974
     
---
 
Consumer:
                       
Residential mortgage
   
---
     
---
     
---
 
Unsecured
   
---
     
---
     
---
 
Home equity
   
---
     
---
     
---
 
Other secured
   
---
     
---
     
---
 
     
---
     
---
     
---
 
Total with no related allowance recorded
 
$
3,955
   
$
3,955
   
$
---
 
                         
With an allowance recorded:
                       
Commercial and industrial
 
$
5,787
   
$
5,787
   
$
448
 
                         
Commercial real estate:
                       
Residential developed
   
177
     
177
     
2
 
Unsecured to residential developers
   
---
     
---
     
---
 
Vacant and unimproved
   
255
     
255
     
12
 
Commercial development
   
---
     
---
     
---
 
Residential improved
   
217
     
217
     
15
 
Commercial improved
   
1,602
     
1,602
     
307
 
Manufacturing and industrial
   
404
     
404
     
10
 
     
2,655
     
2,655
     
346
 
Consumer:
                       
Residential mortgage
   
6,384
     
6,384
     
475
 
Unsecured
   
---
     
---
     
---
 
Home equity
   
1,487
     
1,487
     
111
 
Other secured
   
---
     
---
     
---
 
     
7,871
     
7,871
     
586
 
Total with an allowance recorded
 
$
16,313
   
$
16,313
   
$
1,380
 
Total
 
$
20,268
   
$
20,268
   
$
1,380
 
 
- 19 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2017 (dollars in thousands):
 
 
December 31, 2017
 
Unpaid
Principal
Balance
   
Recorded
Investment
   
Allowance
Allocated
 
With no related allowance recorded:
                 
Commercial and industrial
 
$
3,438
   
$
3,438
   
$
---
 
                         
Commercial real estate:
                       
Residential developed
   
---
     
---
     
---
 
Unsecured to residential developers
   
---
     
---
     
---
 
Vacant and unimproved
   
---
     
---
     
---
 
Commercial development
   
190
     
190
     
---
 
Residential improved
   
15
     
15
     
---
 
Commercial improved
   
---
     
---
     
---
 
Manufacturing and industrial
   
---
     
---
     
---
 
     
205
     
205
     
---
 
Consumer:
                       
Residential mortgage
   
---
     
---
     
---
 
Unsecured
   
---
     
---
     
---
 
Home equity
   
---
     
---
     
---
 
Other secured
   
---
     
---
     
---
 
     
---
     
---
     
---
 
Total with no related allowance recorded
 
$
3,643
   
$
3,643
   
$
---
 
                         
With an allowance recorded:
                       
Commercial and industrial
 
$
2,964
   
$
2,964
   
$
497
 
                         
Commercial real estate:
                       
Residential developed
   
179
     
179
     
4
 
Unsecured to residential developers
   
---
     
---
     
---
 
Vacant and unimproved
   
126
     
126
     
3
 
Commercial development
   
---
     
---
     
---
 
Residential improved
   
1,715
     
1,715
     
69
 
Commercial improved
   
4,928
     
4,928
     
119
 
Manufacturing and industrial
   
179
     
179
     
2
 
     
7,127
     
7,127
     
197
 
Consumer:
                       
Residential mortgage
   
6,638
     
6,638
     
409
 
Unsecured
   
---
     
---
     
---
 
Home equity
   
1,707
     
1,707
     
105
 
Other secured
   
---
     
---
     
---
 
     
8,345
     
8,345
     
514
 
Total with an allowance recorded
 
$
18,436
   
$
18,436
   
$
1,208
 
Total
 
$
22,079
   
$
22,079
   
$
1,208
 
 
- 20 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents information regarding average balances of impaired loans and interest recognized on impaired loans for the three month periods ended March 31, 2018 and 2017 (dollars in thousands):
 
   
Three
Months
Ended
March 31,
2018
   
Three
Months
Ended
March 31,
2017
 
Average of impaired loans during the period:
           
Commercial and industrial
 
$
6,847
   
$
6,843
 
                 
Commercial real estate:
               
Residential developed
   
178
     
185
 
Unsecured to residential developers
   
---
     
---
 
Vacant and unimproved
   
168
     
379
 
Commercial development
   
126
     
189
 
Residential improved
   
1,455
     
4,086
 
Commercial improved
   
3,731
     
6,158
 
Manufacturing and industrial
   
253
     
225
 
                 
Consumer
   
8,067
     
11,495
 
                 
Interest income recognized during impairment:
               
Commercial and industrial
   
302
     
278
 
Commercial real estate
   
74
     
126
 
Consumer
   
85
     
109
 
                 
Cash-basis interest income recognized
               
Commercial and industrial
   
294
     
265
 
Commercial real estate
   
80
     
123
 
Consumer
   
87
     
107
 
 
- 21 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 – LOANS (Continued)

Nonaccrual loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.  The following tables present the recorded investment in nonaccrual and loans past due over 90 days still on accrual by class of loans as of March 31, 2018 and December 31, 2017:
 
 
March 31, 2018
 
Nonaccrual
   
Over 90
days
Accruing
 
             
Commercial and industrial
 
$
201
   
$
---
 
                 
Commercial real estate:
               
Residential developed
   
---
     
---
 
Unsecured to residential developers
   
---
     
---
 
Vacant and unimproved
   
---
     
---
 
Commercial development
   
---
     
---
 
Residential improved
   
15
     
---
 
Commercial improved
   
106
     
---
 
Manufacturing and industrial
   
---
     
---
 
     
121
     
---
 
Consumer:
               
Residential mortgage
   
2
     
---
 
Unsecured
   
---
     
---
 
Home equity
   
---
     
---
 
Other secured
   
---
     
---
 
     
2
     
---
 
Total
 
$
324
   
$
---
 
 
 
December 31, 2017
 
Nonaccrual
   
Over 90
days
Accruing
 
             
Commercial and industrial
 
$
4
   
$
---
 
                 
Commercial real estate:
               
Residential developed
   
---
     
---
 
Unsecured to residential developers
   
---
     
---
 
Vacant and unimproved
   
---
     
---
 
Commercial development
   
190
     
---
 
Residential improved
   
89
     
---
 
Commercial improved
   
106
     
---
 
Manufacturing and industrial
   
---
     
---
 
     
385
     
---
 
Consumer:
               
Residential mortgage
   
2
     
---
 
Unsecured
   
4
     
---
 
Home equity
   
---
     
---
 
Other secured
   
---
     
---
 
     
6
     
---
 
Total
 
$
395
   
$
---
 
 
- 22 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents the aging of the recorded investment in past due loans as of March 31, 2018 and December 31, 2017 by class of loans (dollars in thousands):
 
 
March 31, 2018
 
30-90
Days
   
Greater Than
90 Days
   
Total
Past Due
   
Loans Not
Past Due
   
Total
 
Commercial and industrial
 
$
168
   
$
198
   
$
366
   
$
476,722
   
$
477,088
 
                                         
Commercial real estate:
                                       
Residential developed
   
---
     
---
     
---
     
11,528
     
11,528
 
Unsecured to residential developers
   
---
     
---
     
---
     
2,392
     
2,392
 
Vacant and unimproved
   
---
     
---
     
---
     
41,786
     
41,786
 
Commercial development
   
---
     
---
     
---
     
1,153
     
1,153
 
Residential improved
   
---
     
15
     
15
     
79,518
     
79,533
 
Commercial improved
   
197
     
106
     
303
     
294,563
     
294,866
 
Manufacturing and industrial
   
737
     
---
     
737
     
97,875
     
98,612
 
     
934
     
121
     
1,055
     
528,815
     
529,870
 
Consumer:
                                       
Residential mortgage
   
200
     
---
     
200
     
234,243
     
234,443
 
Unsecured
   
9
     
---
     
9
     
188
     
197
 
Home equity
   
---
     
---
     
---
     
77,666
     
77,666
 
Other secured
   
---
     
---
     
---
     
6,281
     
6,281
 
     
209
     
---
     
209
     
318,378
     
318,587
 
Total
 
$
1,311
   
$
319
   
$
1,630
   
$
1,323,915
   
$
1,325,545
 
 
 
December 31, 2017
 
30-90
Days
   
Greater Than
90 Days
   
Total
Past Due
   
Loans Not
Past Due
   
Total
 
Commercial and industrial
 
$
290
   
$
---
   
$
290
   
$
464,918
   
$
465,208
 
                                         
Commercial real estate:
                                       
Residential developed
   
---
     
---
     
---
     
11,888
     
11,888
 
Unsecured to residential developers
   
---
     
---
     
---
     
2,332
     
2,332
 
Vacant and unimproved
   
---
     
---
     
---
     
39,752
     
39,752
 
Commercial development
   
---
     
190
     
190
     
913
     
1,103
 
Residential improved
   
---
     
89
     
89
     
90,378
     
90,467
 
Commercial improved
   
125
     
---
     
125
     
298,589
     
298,714
 
Manufacturing and industrial
   
---
     
---
     
---
     
97,679
     
97,679
 
     
125
     
279
     
404
     
541,531
     
541,935
 
Consumer:
                                       
Residential mortgage
   
215
     
---
     
215
     
224,237
     
224,452
 
Unsecured
   
10
     
---
     
10
     
216
     
226
 
Home equity
   
76
     
---
     
76
     
82,158
     
82,234
 
Other secured
   
---
     
---
     
---
     
6,254
     
6,254
 
     
301
     
---
     
301
     
312,865
     
313,166
 
Total
 
$
716
   
$
279
   
$
995
   
$
1,319,314
   
$
1,320,309
 
 
- 23 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 – LOANS (Continued)

The Company had allocated $1,380,000 and $1,208,000 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings (“TDRs”) as of March 31, 2018 and December 31, 2017, respectively.  These loans may have involved the restructuring of terms to allow customers to mitigate the risk of foreclosure by meeting a lower loan payment requirement based upon their current cash flow.  These may also include loans that renewed at existing contractual rates, but below market rates for comparable credit.  The Company has been active at utilizing these programs and working with its customers to reduce the risk of foreclosure.  For commercial loans, these modifications typically include an interest only period and, in some cases, a lowering of the interest rate on the loan.  In some cases, the modification will include separating the note into two notes with the first note structured to be supported by current cash flows and collateral, and the second note made for the remaining unsecured debt.  The second note is charged off immediately and collected only after the first note is paid in full.  This modification type is commonly referred to as an A-B note structure.  For consumer mortgage loans, the restructuring typically includes a lowering of the interest rate to provide payment and cash flow relief.  For each restructuring, a comprehensive credit underwriting analysis of the borrower’s financial condition and prospects of repayment under the revised terms is performed to assess whether the structure can be successful and that cash flows will be sufficient to support the restructured debt.  An analysis is also performed to determine whether the restructured loan should be on accrual status.  Generally, if the loan is on accrual at the time of restructure, it will remain on accrual after the restructuring.  In some cases, a nonaccrual loan may be placed on accrual at restructuring if the loan’s actual payment history demonstrates it would have cash flowed under the restructured terms.  After six consecutive payments under the restructured terms, a nonaccrual restructured loan is reviewed for possible upgrade to accruing status.

In situations where there is a subsequent modification or renewal and the loan is brought to market terms, including a contractual interest rate not less than a market interest rate for new debt with similar credit risk characteristics, the TDR and impaired loan designations may be removed.  In addition, the TDR designation may also be removed from loans modified under an A-B note structure.  If the remaining “A” note is at a market rate at the time of restructuring (taking into account the borrower’s credit risk and prevailing market conditions), the loan can be removed from TDR designation in a subsequent calendar year after six months of performance in accordance with the new terms.  The market rate relative to the borrower’s credit risk is determined through analysis of market pricing information gathered from peers and use of a loan pricing model.  The general objective of the model is to achieve a consistent return on equity from one credit to the next, taking into consideration differences in credit risk.  In the model, credits with higher risk receive a higher potential loss allocation, and therefore require a higher interest rate to achieve the target return on equity.

As with other impaired loans, an allowance for loan loss is estimated for each TDR based on the most likely source of repayment for each loan.  For impaired commercial real estate loans that are collateral dependent, the allowance is computed based on the fair value of the underlying collateral, less estimated costs to sell.  For impaired commercial loans where repayment is expected from cash flows from business operations, the allowance is computed based on a discounted cash flow computation.  Certain groups of TDRs, such as residential mortgages, have common characteristics and for them the allowance is computed based on a discounted cash flow computation on the change in weighted rate for the pool.  The allowance allocations for commercial TDRs where we have reduced the contractual interest rate are computed by measuring cash flows using the new payment terms discounted at the original contractual rate.

The following table presents information regarding troubled debt restructurings as of March 31, 2018 and December 31, 2017 (dollars in thousands):
 
   
March 31, 2018
   
December 31, 2017
 
   
Number of
Loans
   
Outstanding
Recorded
Balance
   
Number of
Loans
   
Outstanding
Recorded
Balance
 
Commercial and industrial
   
17
   
$
6,768
     
19
   
$
6,402
 
Commercial real estate
   
33
     
5,629
     
33
     
7,332
 
Consumer
   
96
     
7,871
     
99
     
8,345
 
     
146
   
$
20,268
     
151
   
$
22,079
 
 
- 24 -

Index
MACATAWA BANK CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 3 – LOANS (Continued)

The following table presents information related to accruing troubled debt restructurings as of March 31, 2018 and December 31, 2017.  The table presents the amount of accruing troubled debt restructurings that were on nonaccrual status prior to the restructuring, accruing at the time of restructuring and those that were upgraded to accruing status after receiving six consecutive monthly payments in accordance with the restructured terms as of each period reported (dollars in thousands):

   
March 31,
2018
   
December 31,
2017
 
Accruing TDR - nonaccrual at restructuring
 
$
---
   
$
---
 
Accruing TDR - accruing at restructuring
   
14,720
     
16,809
 
Accruing TDR - upgraded to accruing after six consecutive payments
   
5,424
     
4,955
 
   
$
20,144
   
$
21,764
 

The following tables present information regarding troubled debt restructurings executed during the three month periods ended March 31, 2018 and 2017 (dollars in thousands):
 
     
Three Months Ended March 31,
2018
     
Three Months Ended March 31,
2017
  
   
# of
Loans
   
Pre-TDR
Balance
   
Writedown
Upon
TDR
   
# of
Loans
   
Pre-TDR
Balance
   
Writedown
Upon
TDR
 
Commercial and industrial
   
---
   
$
---
   
$
---
     
---
   
$
---
   
$
---
 
Commercial real estate
   
3
     
492
     
---
     </